I. Check-Specific Rules
Overdrafts:
Definition: A check written for an amount that exceeds the available balance in the account.
Bank's Options:
Pay the check and charge the customer an overdraft fee.
Dishonor the check and return it unpaid to the payee.
Cover the overdraft through an overdraft protection plan if available.
Postdated Checks:
Definition: A check with a future date written on it.
Bank's Obligation: Generally, a bank should not pay a postdated check before the date written on it.
Customer's Right: A customer can order the bank to pay a postdated check before its date, but must give the bank reasonable notice.
Stop-Payment Orders:
Definition: A customer's order to the bank not to pay a specific check.
Requirements:
Must be given in time for the bank to have a reasonable opportunity to act.
Can be oral or written.
Oral stop-payment order is valid for 14 days, while a written order is valid for 6 months and can be renewed.
Bank's Liability: If the bank pays a check in spite of a valid stop-payment order, it is liable to the customer for the amount of the check.
II. Bank Collection Process
Depositary Bank: The first bank to receive a check for deposit.
Intermediary Banks: Any bank (other than the payor bank and the depositary bank) handling the check during the collection process.
Payor Bank: The bank on which the check is drawn (i.e., the bank of the account holder who wrote the check).
Process:
Depositor presents check to the depositary bank.
Depositary bank sends the check through the check collection system.
Check may pass through intermediary banks.
Check is presented to the payor bank for payment.
Payor bank either pays or dishonors the check.
III. Exam Scenarios
Dishonored Checks:
Bank refuses to pay a check.
Reasons: Insufficient funds, stop-payment order, closed account, etc.
Consequences: Payee can sue the drawer of the check for the amount of the check plus any applicable fees.
Improper Endorsements:
Endorsement on the check does not match the name of the payee.
Bank may refuse to pay the check or may be liable for conversion if it pays the check to the wrong person.
Missing or Forged Endorsements:
Endorsement is missing or forged.
Bank may be liable for conversion if it pays the check without a proper endorsement.
Bank Liability:
Bank can be liable for various issues, including paying a check over a valid stop-payment order, paying a check with a forged endorsement, or mishandling the check collection process.
UCC Article 4 governs bank deposits and collections and outlines the rights and responsibilities of banks and customers.
IV. Additional Considerations
Electronic Check Presentment: Check images are electronically transmitted for faster processing and clearing.
Check 21 Act: Allows for the use of substitute checks (electronic images of original checks) to replace the physical movement of paper checks.
Regulation CC (Expedited Funds Availability Act): Sets rules for how quickly banks must make funds available to customers after a check is deposited.
The Role of the Federal Reserve System: The Federal Reserve plays a key role in the check collection process by clearing checks between banks and ensuring the smooth operation of the payment system.
